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Market Bulls Should Consider These Charts

Tyler Durden's picture





 

Submitted by Lance Roberts of STA Wealth Management,

There have been a litany of articles written recently discussing how the stock market is set for a continued bull rally.  The are some primary points that are common threads among each of these articles which are:  1) interest rates are low, 2) corporate profitability is high, and; 3) the Fed's monetary programs continue to put a floor under stocks.  The problem is that while I do not disagree with any of those points - they are all artificially influenced by outside factors.  Interest rates are low because of the Federal Reserve's actions, corporate profitability is high due to accounting rule changes following the financial crisis and the Fed's liquidity program artificially inflates stock prices.

However, while the promise of a continued bull market is very enticing it is important to remember, as investors, that we have only one job:  "Buy Low/Sell High."  It is a simple rule that is more often than not forgotten as "greed" replaces "logic."  However, it is also that simple emotion of greed that tends to lead to devastating losses.  Therefore, if your portfolio, and ultimately your retirement, is dependent upon the thesis of a continued bull market you should at least consider the following charts.


It is often stated that valuations are still cheap.   The chart below shows Dr. Robert Shiller's cyclically adjusted P/E ratio.  The problem is that current valuations only appear cheap when compared to the peak in 2000.  In order to put valuations into perspective I have capped P/E's at 25x trailing earnings as this has been the level where secular bull markets have previously ended.  I have noted the peak valuations in periods that have exceeded that level.

PE-Deviation-010914

The next chart is Tobin's Q Ratio.  James Tobin of Yale University, Nobel laureate in economics, hypothesized that the combined market value of all the companies on the stock market should be about equal to their replacement costs. The Q ratio is calculated as the market value of a company divided by the replacement value of the firm's assets.  With the exception of the "tech bubble" we are near the peak of every major bull market in history.

Q-Ratio-SP500-010914

One argument that I hear made consistently is that retail investors are just now beginning to jump into the market.  The chart below shows the percentage of stocks, bonds and cash owned by individual investors according to the American Association of Individual Investor's survey.  As you can see, equity ownership and near record low levels of cash suggest that the individual investor is "all in."

AAII-Allocations-010914

Of course, with investors fully committed to stocks it is not surprising to see margin debt as a percentage of the S&P 500 at record levels also.  It is important to notice that sharp spikes in this ratio have always coincided with market corrections of which some have been much worse than others.

Margin-Debt-SP500-010914

Bob Farrell's rule #9 basically states that when everyone agrees; something else is bound to happen.  The next two charts show the level of "bullishness" of both individual investors (AAII Survey) and professional money managers (INVI Survey).  Surprisingly, professional money managers are more exuberant than individuals.  It is interesting to note that the 8-week moving average of bullish sentiment for individuals has declined prior to the eventual peak in the market.

AAII-Bullish-Sentiment-8wk-010914

As I stated above - professional investors are just plain "giddy" about the market. 

INVI-Bullish-Sentiment-SP500-010914

Lastly, an important chart I have shown previously, the deviation of the S&P 500 and the Wilshire 5000 from their respective 36-month moving average is at levels that have only been seen at four other periods previously. 

S&P-500-Wilshire-Dev-36M-010914

As a money manager, I am currently long the stock market.  I must be or I potentially suffer career risk.  However, my job as an advisor is not only to make money for my clients, but also to preserve their gains, and investment capital, as much as possible.  Understanding the bullish arguments is surely important but the risk to investors is not a continued rise but the eventual reversion that will occur.  Unfortunately, since most individuals only consider the "bull case," as it creates confirmation bias for their "greed" emotion, they never see the "train coming."

Hopefully, these charts will give you some food for thought.  Remember, every professional poker player knows how to spot a "pigeon at the table."  Make sure it isn't you.

Why do I keep humming "Come'on Take The Money And Run."

 


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Fri, 01/10/2014 - 12:07 | Link to Comment Magnum
Magnum's picture

Gold is soaring today.

Fri, 01/10/2014 - 12:10 | Link to Comment Headbanger
Headbanger's picture

And don't forget Put/Call Ratio:

http://1.bp.blogspot.com/-dJUhBfMZWP4/Us3iNwu_QlI/AAAAAAAAXhU/WhzrH8yhat...

From Daneric's blog

Fri, 01/10/2014 - 12:11 | Link to Comment Four chan
Four chan's picture

we aint seen nothing yet.

Fri, 01/10/2014 - 14:25 | Link to Comment SmallerGovNow2
SmallerGovNow2's picture

+1 for the rack.  If I've already done this to you before, don't be so hard on me, I'm a sucker for a good rack...

Fri, 01/10/2014 - 12:13 | Link to Comment Grande Tetons
Grande Tetons's picture

New rule. Soaring should be used to describe moves over 5 percent. 

Tanking should be used in a similar fashion. 

 

Fri, 01/10/2014 - 12:42 | Link to Comment GrinandBearit
GrinandBearit's picture

Agreed.  Been thinking this for a while.  Too much drama on here lately.

Fri, 01/10/2014 - 12:14 | Link to Comment PrecipiceWatching
PrecipiceWatching's picture

Today, tomorrow, next week.  Who cares?

I doubt few here on ZH care to play the short-term, market timing game with PMs.

For me at least, that is hardly their purpose.  A tool of a much different sort.....

Fri, 01/10/2014 - 12:16 | Link to Comment Rubbish
Rubbish's picture

I've made $1 oz. on my silver physical by playing the miners in and out twice in the last 2 weeks. Miners are volitile and good tools to make a little coin, that is if you think metals have consolidated.

Fri, 01/10/2014 - 14:32 | Link to Comment SAT 800
SAT 800's picture

The Fed's Bullard stated today for publication, that "inflation will be increasing in 2014". I guess he had a case of foot in mouth disease. Seems to have helped out the metals, tho.

Fri, 01/10/2014 - 12:19 | Link to Comment HedgeAccordingly
HedgeAccordingly's picture

Welp Senator Warren is looking for her new Fed mouthpeices al hunt interview --> http://hedge.ly/1dk9zCP 

Fri, 01/10/2014 - 12:21 | Link to Comment ...out of space
...out of space's picture

i take short on s&p after nfp. 

Fri, 01/10/2014 - 12:22 | Link to Comment disabledvet
disabledvet's picture

bull markets are DEFLATIONARY. they cut costs to the bone and run on dimes. i could very easily see not only treasury yields collapse in rate and soar in value...but gold get absolutely crushed and millions of tons "suddenly appears from outer space." can't speak for coal...but outer space has specialty metals galore. so no...you CAN have a bull market WITH plunging interest rates AND deflation. what you don't want to have is debt...god help you if suddenly a "gold standard" appears in an energy Super State like North Dakota. "they have big money, a big State and a HUGE Bank to go with that." If they're not thinking Elon Musk then they're not thinking. If they ARE thinking Elon Musk then they can do a lot more than Saudi Arabia ever did that's fer sure.

Fri, 01/10/2014 - 12:36 | Link to Comment Pale Horse
Pale Horse's picture

how is this bull market deflationary?  Expansionary federal policy should create INFLATION, except when the primary dealers just sit on the money like they have been

Fri, 01/10/2014 - 12:26 | Link to Comment kill switch
kill switch's picture

OT

Now we have an idea of what to expect from our new Unaffordable Care Act.

 

First patient in Chicago treated under Obamacare

 

http://truenewsusa.blogspot.com/2013/12/the-nations-first-obamacare-clinic.html

Fri, 01/10/2014 - 12:49 | Link to Comment Michelle
Michelle's picture

Buy low, sell high. It's that simple, just ask Cohen or Corzine.

Sat, 01/11/2014 - 01:18 | Link to Comment dunce
dunce's picture

Until QE is really tapered and iterest rates start rising all will remain the same, irrational prices.

Fri, 01/10/2014 - 15:21 | Link to Comment Finnman
Finnman's picture

I think it's now ECB and Mario Draghi who will give some booze to bulls. Just waite some months.

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